As Energy Future Holdings Corp.’s board met last month to plan for bankruptcy, representatives of every influential creditor from Apollo Global Management LLC to Oaktree Capital Group LLC filed into a New York law office, except one.
Absent was the delegate from Fidelity Investments, according to two people with knowledge of the discussions. The second-biggest mutual-fund manager in the U.S. faced a conflict because a strategy championed by some of Fidelity’s fellow senior lenders had the potential to wipe out a $500 million investment it also had in the junior bonds from one of about a half-dozen debt-issuing units of the power producer.
Fidelity’s more than $1 billion stake in Dallas-based Energy Future’s debt illustrates why creditors have failed to agree on a plan to restructure $43.6 billion of bonds and loans as the target of the largest leveraged buyout in history veers toward bankruptcy. Any reorganization of the former TXU Corp. needs to resolve claims on 75 bonds and loans held by at least 600 creditors, according to data compiled by Bloomberg.
“This capital structure is fraught with problems and that’s the risk that you have investing in it,” Peter Thornton, an analyst at Montpelier, Vermont-based debt-researcher KDP Investment Advisors Inc., said in a telephone interview. “If you think you have something that can be challenged later by someone else in the capital structure, you got yourself a problem, and if it’s really complex like TXU, you’re not going to know until it’s all done with.”
Fidelity owns debt in at least seven parts of Energy Future, Bloomberg data show. Because varying levels of seniority in the holdings determine which creditors are paid first, the Boston-based firm that oversees $1.9 trillion globally has been left in the position where any reorganization decision would favor some assets over others.
The debt restructuring talks between the largest electricity provider in Texas and its creditors that would have avoided $270 million in interest payments to junior bondholders broke apart hours before the Nov. 1 coupon deadline.
When Energy Future paid the coupons, it benefited investors that probably won’t be entitled to assets in a Chapter 11 restructuring while reducing the recovery of secured lenders.
“The company thought by keeping everyone negotiating and having a consensual plan that they could save much more in value, but they really misjudged how upset the first-lien lenders would be,” Thornton said.
Talks between the lender committees that were trying to protect their holdings in a negotiated bankruptcy fell apart after Fidelity failed to show up at an Oct. 28 meeting at Kirkland & Ellis LLP’s offices on Manhattan’s Lexington Avenue, said the people, who asked not to be identified without authorization to speak publicly.
Identified in regulatory filings as a “significant creditor” in the confidential talks, Fidelity was seen by the debtholders as a party that could help bring the disparate groups together after eight months of negotiations, one of the people said. Talks rescheduled for later that week failed to gain traction.
“We are aware of meetings and conversations going on amongst various creditor groups, and we have been an active participant in those discussions,” Adam Banker, a spokesman for Fidelity, said yesterday in a telephone interview.
Adam McGill, a spokesman for Energy Future, and Rohini Pragasam at Kirkland & Ellis in New York, the law firm representing the electricity generator in the restructuring, declined to comment.
KKR & Co., Goldman Sachs Capital Partners and TPG Capital took Energy Future private in 2007 for $48 billion, an investment that was predicated on rising natural gas prices. Instead, prices fell as the development of hydraulic fracturing created a surge in U.S. gas supplies, triggering 10 straight quarterly losses at the company since 2011.
The private-equity firms have been seeking to forge a bankruptcy plan that would keep the power giant together, giving them a chance to retain an equity stake. A failure to keep the regulated and deregulated portions of the company intact could wipe out unsecured classes of investors with a $2 billion tax bill.
Apollo, Oaktree and Centerbridge Capital Partners LP were part of a committee of secured lenders that formed to represent the interests of loan holders in Energy Future’s deregulated Texas Competitive Electric Holdings Co. unit, which owns the power generator Luminant and the retail seller TXU Energy. Those debt holders would likely receive the majority of equity in a reorganized company.
Last month, as the deadline for the coupon payment approached, the group threatened to seek a breakup of the company if the coupon payments owed to more junior bond investors were made, according to a Nov. 1 regulatory filing.
Fidelity, the biggest mutual-fund firm in the U.S. after Vanguard Group Inc., holds at least $275.6 million of $19.5 billion of loans at Texas Competitive, according to Bloomberg data that tallies the fund manager’s investments through regulatory filings. Not all of its funds disclose that information.
If Texas Competitive were spun off, the transaction would create a gain because it would be considered an asset sale, triggering the tax liability, according to an April 15 regulatory filing. The priority of such a tax would be in dispute, and a bankruptcy judge could be the arbiter of whether the U.S. Internal Revenue Service can jump in front of bondholders seizing Energy Future’s assets, according to CRT Capital Group LLC in Stamford, Connecticut.
The company’s most senior lenders are poised to cede more cash as it prepares to make about $390 million in additional payments to other debtors due through March, Bloomberg data show, which then may raise doubts among auditors about its ability to remain a going concern, triggering a default.
Texas Competitive’s $1.83 billion of 10.25 percent unsecured bonds due November 2015, which paid a coupon on Nov. 1, traded yesterday at 7.4 cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The same unit’s $3.81 billion first-lien term loan that expires in October 2014 traded at 72.6 cents yesterday, Bloomberg prices show.
The Energy Future LBO capped a buyout boom from 2005 to 2007 that spawned supersized takeovers in which private-equity firms combined capital from investors and a larger portion of borrowed money with the goal of improving cash flows and selling years later at a profit.
“These leveraged buyouts always have complicated capital structures because that’s how you get your leverage,” Erik Gordon, a business professor at the University of Michigan, said in a telephone interview. “You’ve got to get a lot of lenders lined up and they buy different kinds of debt so it’s complicated and they have conflicts of interest.”